Capital Stock

The term ‘Capital’ is used in various fields including business finance, capital budgeting, investing, and economics. Capital essentially means wealth in the form of money or assets owned by an individual or organisation to start a company or invest. It is also a type of stock that you can invest in. To learn more about capital stock, read on.

• Capital stock means the total amount of equity and preferred shares a company is authorised to issue. The capital stock of a company is highlighted under the shareholder’s equity section of its balance sheet.
• Capital stock is all the shares the company is legally allowed to issue.
• Issuing capital stock helps companies raise capital without an add-on debt burden. Companies use this capital for different purposes like business expansion, R&D efforts, acquisitions, or debt repayment.
• Issuing capital stock can lead to relinquishing more control in the company as well as dilution in the value of outstanding shares.

Capital stock refers to the amount of common and preferred shares a company is authorised to issue according to its incorporation charter or article of association. In other words, capital stock is defined as the maximum number of shares the company can legally issue to raise capital. This information is recorded in the shareholder's equity section of the company’s balance sheet. 

The meaning of capital stock indicates that companies issue shares to raise capital in exchange for an ownership stake in the company. These shares can be bought and sold on the stock exchange. Issuing capital stock primarily serves as a method of raising capital for various purposes like expansion, business development, debt repayment, buying equipment, funding acquisitions, and financing R&D efforts.

The number of outstanding shares issued to investors is not always the same as the capital stock of the company. The capital stock is the authorised share capital of the company, which means it is the maximum number of shares the company can legally issue to the public. Outstanding shares, on the other hand, are shares that have been actually issued out of the authorised capital and remain outstanding to the shareholders. In simple words, outstanding shares are often a subset of the company’s capital stock.

A company’s board of directors decides on the maximum number of shares that can be issued. The shares issued can be common equity shares or preference shares. Businesses can issue shares over time, depending on the authorised share capital limits. Authorising a large number of shares that can be issued over time helps companies save on legal costs.

As mentioned earlier, capital stock includes both common and preference stocks. Common shares are equity shares of the company traded on the stock exchange. Common shareholders command voting rights and receive dividend payments depending on the financial performance of the company. Preference shareholders, on the other hand, are prioritised over common shareholders for dividend payments. They also have priority claims over the assets of the company in case of its liquidation. Since the dividend income of preference shareholders is fixed, these shares can lose value under high inflationary pressures.

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According to the definition of capital stock, it includes all the common and preferred shares a company can legally issue as per the directives of its incorporation charter. This means share trading does not have an impact on the capital stock of the company. Companies log the details of its current shareholders in a register. This shareholder’s register is also updated each time there is a change in ownership of the company.

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The value of a company’s capital stock is mentioned in the shareholder’s equity section of the balance sheet. Capital stock valuation is calculated by considering the par value (face value) of the shares and the number of shares issued.

The par value of a share is the nominal per share value set by the company’s charter. It is the minimum amount at which these shares can be bought. Par value can vary depending on the share class in question. Companies can choose to set a par value for their shares when authorising shares. This par value has no relation with the market value of the shares, which is the price at which the shares are currently trading on the market. Number of issued shares, on the other hand, refers to a total of both common and preferred shares issued by the company.

The following formula is used to calculate the value of capital stock:

Let’s take an example to understand how to calculate the value of capital stock using the above-mentioned formula. Suppose company X issues 4000 common shares at a par value of Rs. 400 and 3000 preferred shares at a par value of Rs. 300. Then, the value of the capital stock will be:

Value of capital stock = (4,000 x 400) + (3,000 x 300)

          = 16,00,000 + 9,00,000

          = Rs. 25,00,000

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The chief advantage of capital stock issuance is that it allows companies to raise capital without an additional debt burden. For the investors, capital stocks mean gaining ownership stake in well-established and profitable ventures, voting rights, and dividend payout.

If a company issues bonds or takes a loan to secure the required capital instead of issuing capital stock, it has to stick to a set repayment schedule. With capital stock, the company does not need to repay the invested sum or worry about paying a fixed interest on the invested amount. In other words, it allows the company to get access to capital without increasing its fixed cost.

Despite these advantages, capital stock issuance also has certain drawbacks that companies need to recognise. Issuing capital stock dilutes the value of the existing shares of the company, potentially reducing the value of the equity held by its current shareholders. Capital stock means ownership of the company’s equity. Therefore, if the founders decide to sell a majority of this equity to outside investors, it can result in the loss of control over the company’s future.

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Investing in the capital stock of a company is simply purchasing common or preferred shares of the company to gain an ownership stake in the company. Companies issue capital stock to raise capital for various purposes like business expansion, acquisitions, product development, and fund operations. In exchange for their investments, shareholders enjoy partial ownership of the company, along with perks like voting rights and dividend income.